Talking Top Quartile with David Schnadig of Cortec Group

The vintage 2011 Cortec Group Fund V, L.P., a domestic buyout and corporate finance fund, earned a 2.8x multiple and an IRR of 52.8 percent as of Dec. 31, 2015 for the State Board of Administration of Florida. The performance beat the 20.3 percent top quartile threshold for vintage 2011 funds, according to an analysis of public pension fund data by Buyouts.

David Schnadig, a managing partner of Cortec Group, spoke about the fund by phone with Buyouts on Dec. 14.

Cortec Funds III, IV and V have had top-quartile performances. What’s the common theme here?

Our business model, which I’ll discuss more, is the primary driver of our results. That said, our leadership team, including myself, Jeff Lipsitz, founder Scott Schafler, and Mike Najjar, has worked together since 2004. Jeff, Scott and I have collaborated since 1998. This continuity of team and strategy is a key element of our success. In fact, since Jeff and I became partners with Scott in 1999, when we raised Cortec III, every fund we’ve had has been top quartile. Fund V is a continuation of this performance.

What kind of returns are you talking about?

From a gross cash-on-cash return perspective (since fee offsets have changed over time), Cortec III, a 2000 vintage fund, was 2.8x. Cortec IV, our 2006 fund, should be a 2.7x. In that fund, we have only one company left to sell and we are just about to bring it to market. Fund V is also a top quartile fund.

So the business model drives your performance across funds?

We believe so. Whether it’s Cortec III, IV, V, or VI, we buy most of the companies we seek to acquire. We work best with entrepreneurs; we work closely with companies once we buy them and we build great companies over time. Our approach is very different from most private equity firms. About half the firm’s leadership are people that never worked on Wall Street or worked there for a short time. Instead, they’re business leaders that came out of consumer products, healthcare, business products, distribution and services companies. Those experiences are at the core of what we try to bring to our management teams, including the lessons we’ve learned and the mistakes we’ve made in prior lives. We also have a good group of folks with Wall Street experience. How we put those two groups together is a fundamental difference from our brethren.

Exactly how is that different?

We’ve never had the operating model that many private equity firms do — an operating partner in Cincinnati that flies around the world and stops in every once in a while at each portfolio company. We have five people that assess each acquisition. On platform deals, we always have one managing partner, a partner, and a managing director. We’re very top heavy. The same five people that start the deal are there at the finish. Our average hold period is six years. We look at 550 potential platform acquisitions a year that fit our criteria. We visit an average of 10 to 15 a year. That’s it. We typically pursue a third of those — three to five. We go hard after them and we buy three of them, on average. We close an unusually high percentage of companies we pursue.

To have those results, you have to differentiate yourself. We don’t do it by paying the highest price. We’ve been told by our portfolio-company CEOs that we’re rarely the highest price. What we’re doing differently is we’re coming to the table with the knowledge we get from doing our due diligence in advance of our meeting, experience that’s different from other private equity funds, and always with a ton of respect for what the entrepreneur has built. With 75 percent of the platforms that we’ve bought since 1999, we’re the first control institutional capital. So we partner with entrepreneur/founders the majority of the time we buy a company.

Any more color on how you talk to entrepreneurs?

When you talk to an owner, you want them to know that we’re the private equity firm that actually understands their business.  Entrepreneurs like to talk to other business owners like themselves to share experiences and lessons. We have a list of 28 executives for them. They can talk to prior business owners that are similar to themselves. Most other PE firms don’t have this type of reference list. Notably, 12 of our former or current managers invested in our latest fund, Cortec VI, which closed in 2015.

How did that happen?

We did not solicit them. When we started to raise Fund VI, we asked our executives to provide references for us. We started getting emails back from our CEOs asking if they could invest. It was so rewarding … one of the highlights I’ve had at this job…

So you must already have a close relationship with your portfolio companies in the first place?

The other things we do that are really unusual include meeting every month on site at our portfolio companies for about a day and a half. The CEO and all his direct reports take part — the head of sales, the head of IT, the head of HR — all of the areas that make a company tick. We talk about the risks, opportunities and challenges they’re facing.

We’re also super-involved in recruitment. Our view is that people, processes and systems drive value in businesses over time. When you’re the first institutional money into a company, you’re usually changing all three. We help on various critical projects, such as working in the field with salespeople or interviewing leading candidates for key positions. Overall, it’s not a typical owner/portfolio company relationship. We serve our companies as teammates.

Yeti Holdings, a maker of coolers, drinkware and other gear in Fund V, filed to go public over the summer. What’s it like to own a company that’s earned a mention in a hit country song, Buy Me a Boat, by Chris Janson?

It’s a once in a lifetime deal. The cultural awareness of Yeti is very strong in the South. It’s really part of people’s lives. What’s really cool, though, is if you go to an REI store in NYC, you’ll see Yeti products there too. Yeti has grown by dramatically increasing its product breadth beyond coolers, T-shirts and hats. We’ve been really good at introducing new products that bring it beyond the hunting and fishing community, such as through soft coolers and vacuum-insulated cups and bottles. …

In May 2016, Yeti paid a $451 million dividend to its stockholders. Has that provided a strong basis for your returns for Fund V before Yeti goes public?

That dividend included all shareholders. We don’t own 100 percent of the company —we own about two-thirds of the stock. While we don’t typically do dividend recaps, the company had no debt prior to that transaction, and we put less than 2.5x EBITDA of debt on the company. It allowed us to return about half of Fund V to our LPs. The best part is that we still have all our ownership of Yeti and the seven other businesses in the fund.

So outside of Yeti, what’s been driving returns for Fund V?

We have eight companies in the fund. While one is doing obscenely well, all but one are currently above cost, and that latter one is now trending nicely. Even excluding the standout performance of Yeti, we believe Fund V will generate attractive returns. We’ve got two companies that are performing very well: Weiman Products, a provider of specialty cleaning products, and Barcodes Inc, a distributor of automatic identification capture products.

How did Fund V contribute to the evolution of the firm?

I think of it as a logical progression. Our strategy was the same as with prior funds. From an investor standpoint, we mainly grew with our existing LPs. Most were in Fund III and IV, but we added a few new LPs from family offices and international markets. Our goal is to have a very diverse group of LPs across classes over time.

Photo of David Schnadig courtesy of the firm